©1997 International Monetary Fund

World economic outlook (International Monetary Fund)

World economic outlook: a survey by the staff of the International
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ISSN 0251-6365)
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ISSN 0258-7440 = World economic and financial surveys
ISSN 0256-6877 = World economic outlook (Washington)
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Contents

Page

Assumptions and Conventions vii

Preface ix

Chapter I. Global Economic Prospects and Policies 1

Advanced Economies 4
Developing Countries 12
Transition Countries 14

Chapter II. World Economic Situation and Short-Term Prospects 15

Economic Activity, Inflation, and Policy Stances in Advanced Economies 16
Economic Situation and Prospects in Developing Countries 29
Developments and Prospects in Transition Countries 31
Financial and Foreign Exchange Markets 33
External Payments, Financing, and Debt 39

Chapter III. Meeting the Challenges of Globalization in the Advanced Economies 45

Features of Modern Globalization 45
Causes and Implications of Deindustrialization 47
Trade and Wages 53
Capital Market Integration and Implications for Policy 59

Chapter IV. Globalization and the Opportunities for Developing Countries 72

Forces of Integration 72
Implications for Relative Income Patterns and Convergence 76
Policies to Boost Growth and Promote Convergence 80
Economic Convergence and the Importance of Policy Complementarities 89
Reaping Gains from Globalization and Avoiding Marginalization 91

Chapter V. Integration of the Transition Countries into the Global Economy 93

Liberalization of Trade and Payments 94
Trade Liberalization 95
Revival and Reorientation of Trade 96
Progress with Financial Integration 100
Regional Integration Initiatives 110

Annex
Globalization in Historical Perspective 112
International Trade 112
Capital Market Integration 113

iii
 CONTENTS

Page

Boxes
Chapter
III 1. Revised Country Classification 4
2. Policy Assumptions Underlying the Projections 10
III 3. Rising Petroleum Prices in 1996 17
4. United States: Sources and Implications of Bias
in the Consumer Price Index 20
5. Problems in Measuring Output in Transition Countries 34
III 6. Global R&D Spillovers 48
7. Deindustrialization and the Labor Market in Sweden 54
8. Ireland Catches Up 62
IV 9. Measuring Productivity Gains in East Asian Economies 82
10. Stabilization and Reform of Formerly Centrally Planned Developing
Economies in East Asia 86
IV 11. Normalizing the Transition Countries’ Creditor Relations 104
12. Foreign Direct Investment Strategies in Hungary and Kazakstan 108

Statistical Appendix 117

Assumptions 117
Data and Conventions 117
Classification of Countries 118
List of Countries 129
Output (Tables A1–A7) 131
Inflation (Tables A8–A13) 142
Financial Policies (Tables A14–A21) 150
Foreign Trade (Tables A22–A26) 159
Current Account Transactions (Tables A27–A32) 167
Balance of Payments Financing (Tables A33–A37) 179
External Debt and Debt Service (Tables A38–A43) 190
Flow of Funds (Table A44) 200
Medium-Term Baseline Scenario (Tables A45–A46) 205

Tables
Chapter
III 1. Overview of the World Economic Outlook Projections 5
III 2. Advanced Economies: Real GDP, Consumer Prices, and Unemployment Rates 18
3. Major Industrial Countries: Questions About Inflationary Pressures 19
4. Major Industrial Countries: General Government Fiscal Balances and Debt 22
5. European Union: Convergence Indicators for 1995, 1996, and 1997 27
6. Selected Developing Countries: Real GDP and Consumer Prices 30
7. Countries in Transition: Real GDP and Consumer Prices 32
8. Selected Economies: World Export Market Shares 41
9. Selected Economies: Current Account Positions 42
10. Developing Countries: Capital Flows 43
III 11. Costs of Air Transportation, Telephone Calls, and Computer Price Deflator 46
12. Industrial Countries: Growth of Output and Employment 52
13. Cross-Border Transactions in Bonds and Equities 60
14. Gross Foreign Direct Investment plus Portfolio Investment 60
15. Foreign Exchange Trading 64
IV 16. Advanced Economies Versus Developing Countries Including
Newly Industrialized Economies: Diversification of Exports 73
17. Developing Countries and Asian Newly Industrialized Economies:
Increased Polarization and Reduced Mobility in Cross-Country
Relative Income 79

iv
 Contents

Page

18. Developing Countries: Convergence and Growth in Selected Countries 81

19. Developing Countries and Asian Newly Industrialized Economies:
Policies and Economic Performance 84
20. Developing Countries Including Asian Newly Industrialized Economies:
Relationship Between Policies and Growth, 1985–95, and Conditional
Probabilities of Success 90
IV 21. Countries in Transition: Progress in Integration and
Economic Performance 94
22. Countries in Transition: Dollar Wages in Manufacturing or Industry 100
23. Countries in Transition: Net Medium- to Long-Term Financial Flows 102
24. Countries in Transition: Ratios of Gross External Debt to Export 105
25. Countries in Transition: Credit Ratings and Country Risk Rankings 106
26. Countries in Transition: Net Foreign Direct Investment 107

Box
4 Sources of Bias in the U.S. Consumer Price Index, 1996 20
8 Net EU Transfers 63
9 Selected Developing Countries and Newly Industrialized Economies in Asia:
Estimates of Total Factor Productivity Growth 83
10 Comparison Between Developing Countries in East Asia Moving Away from
Central Planning and Selected Transition Countries in Eastern Europe
and the Former Soviet Union 87

Charts
Chapter
III 1. World Industrial Production 1
2. World Indicators 2
3. European Union: General Government Budget Positions 8
III 4. Commodity Price Indices 15
5. Major Industrial Countries: Output Gaps 16
6. Three Major Industrial Countries: Policy-Related Interest Rates and
Ten-Year Government Bond Yields 23
7. Major Industrial Countries: Monetary Conditions Indices 24
8. Selected European Countries: Real Total Domestic Demand 25
9. European Union and the United States: Indicators of Consumer Confidence 26
10. Selected Asian Countries: Growth in Export Revenues 28
11. Selected Transition Countries: Inflation 33
12. Major Industrial Countries: Nominal Interest Rates 36
13. Major Industrial Countries: Effective Exchange Rates 37
14. United States: Stock Market Indicators 38
15. Emerging Market Countries: Equity Prices 40
16. Elasticity of World Trade with Respect to World Output 40
17. Developing Countries and Countries in Transition: External Debt
and Debt Service 44
III 18. Selected Advanced Economies: Employment by Sector as a Share of
Total Civilian Employment 47
19. Selected Advanced Economies: Value Added by Sector as a Share
of GDP in Current Prices 50
20. Selected Advanced Economies: Value Added in Manufacturing as a Share
of GDP in Constant Prices 51
21. Selected Advanced Economies: Balance of Trade in Manufactured Goods 51
22. Changing Structure of Employment 52
23. Selected Advanced Economies: Employment 53
24. Selected East Asian Economies: Share of Manufacturing in Employment 53
25. Selected Advanced Economies: Changes in Ratios of Earnings Deciles 56

v
 CONTENTS

Page

26. Selected Advanced Economies: Unemployment Rates 57

27. Selected Advanced Economies: Foreign Direct Investment Outflows 61
28. Selected Advanced Economies: Dispersion of Covered Interest Differentials 65
29. Selected Advanced Economies: Mean and Dispersion of Nominal
Short-Term Interest Rates 66
30. Advanced Economies: U.S. Dollar Exchange Rate and Inflation Differential 67
31. Selected Advanced Economies: Mean and Dispersion of Real
Short-Term Interest Rates 68
32. Selected Advanced Economies: Mean and Dispersion of
Nominal Bond Yields 69
IV 33. Developing Countries and Asian Newly Industrialized
Economies (NIEs): Trade 74
34. Developing Countries: Net Private Capital Flows 75
35. Developing Countries: Net Private Capital Flows, 1990–96 76
36. Advanced, Developing, and Transition Economies: Current
Account Convertibility 76
37. Developing Countries and Asian Newly Industrialized Economies (NIEs):
Real Per Capita Income 77
38. Developing Countries and Asian Newly Industrialized Economies (NIEs):
Relative Economic Performance 78
39. Advanced and Developing Economies: Convergence in
Per Capita Income, 1965–95 80
40. Developing Countries and Asian Newly Industrialized Economies:
Convergence in Absolute Income, 1965–95 80
41. Selected Economies: Exports, Imports, and Per Capita Real Income 85
IV 42. Countries in Transition: Ratio of Trade to Output 97
43. Central and Eastern European Countries: Composition of
Trade by Partner 98
44. Selected Countries in Transition: Real Exchange Rates vis-à-vis
U.S. Dollar 99
45. Countries In Transition: Medium- to Long-Term Net Financial Flows 101

Annex
46. Advanced Economies: Effective Tariff Rates 112
47. Selected Countries: External Capital Flows 114
48. Selected Major Industrial Countries: Current Account Balances 115
49. Selected Countries: Dispersion of Real Interest Rates 115

Box
3 West Texas Oil Prices: Spot and Futures Contracts 17
6 Impact of Increased R&D on Output and Consumption 49
7 Employment by Sector as a Share of Total Civilian Employment 55
8 Per Capita GDP 62
Ireland: General Government Budget Balance and General Government Debt 62
Ireland: Competitiveness Indicators 63

vi
Assumptions and Conventions

A number of assumptions have been adopted for the projections presented in the World
Economic Outlook. It has been assumed that real effective exchange rates will remain constant
at their average levels during March 1–18, 1997 except for the bilateral rates among the
European exchange rate mechanism (ERM) currencies, which are assumed to remain constant
in nominal terms; that established policies of national authorities will be maintained (for spe-
cific assumptions about fiscal and monetary policies in industrial countries, see Box 2); that
the average price of oil will be $19.69 a barrel in 1997 and $18.36 a barrel in 1998, and remain
unchanged in real terms over the medium term; and that the six-month London interbank of-
fered rate (LIBOR) on U.S. dollar deposits will average 6.0 percent in 1997 and 6.1 percent in
1998. These are, of course, working hypotheses rather than forecasts, and the uncertainties sur-
rounding them add to the margin of error that would in any event be involved in the projec-
tions. The estimates and projections are based on statistical information available at the end of
March 1997.

The following conventions have been used throughout the World Economic Outlook:
... to indicate that data are not available or not applicable;
— to indicate that the figure is zero or negligible;
– between years or months (e.g., 1994–95 or January–June) to indicate the years or
months covered, including the beginning and ending years or months;
/ between years or months (e.g., 1994/95) to indicate a fiscal or financial year.
“Billion” means a thousand million; “trillion” means a thousand billion.
“Basis points” refer to hundredths of 1 percentage point (e.g., 25 basis points are equivalent to
!/4 of 1 percentage point).
Minor discrepancies between sums of constituent figures and totals shown are due to rounding.

* * *

As used in this report, the term “country” does not in all cases refer to a territorial entity that
is a state as understood by international law and practice. As used here, the term also covers some
territorial entities that are not states but for which statistical data are maintained on a separate
and independent basis.

vii
Preface

The projections and analysis contained in the World Economic Outlook are an integral ele-
ment of the IMF’s ongoing surveillance of economic developments and policies in its member
countries and of the global economic system. The IMF has published the World Economic
Outlook annually from 1980 through 1983 and biannually since 1984.
The survey of prospects and policies is the product of a comprehensive interdepartmental re-
view of world economic developments, which draws primarily on information the IMF staff
gathers through its consultations with member countries. These consultations are carried out in
particular by the IMF’s area departments together with the Policy Development and Review
Department and the Fiscal Affairs Department.
The country projections are prepared by the IMF’s area departments on the basis of interna-
tionally consistent assumptions about world activity, exchange rates, and conditions in inter-
national financial and commodity markets. For approximately 50 of the largest economies—
accounting for 90 percent of world output—the projections are updated for each World
Economic Outlook exercise. For smaller countries, the projections are based on those prepared
at the time of the IMF’s regular Article IV consultations with member countries or in connec-
tion with the use of IMF resources; for these countries, the projections used in the World
Economic Outlook are incrementally adjusted to reflect changes in assumptions and global
economic conditions.
The analysis in the World Economic Outlook draws extensively on the ongoing work of the
IMF’s area and specialized departments, and is coordinated in the Research Department under
the general direction of Michael Mussa, Economic Counsellor and Director of Research. The
World Economic Outlook project is directed by Flemming Larsen, Deputy Director of the
Research Department, together with Graham Hacche, Chief of the World Economic Studies
Division.
Primary contributors to the current issue are Francesco Caramazza, Robert F. Wescott,
Staffan Gorne, Mark De Broeck, Paula De Masi, Jahangir Aziz, Kornélia Krajnyák, Ramana
Ramaswamy, Phillip Swagel, and Cathy Wright. Other contributors include Paul Armknecht,
Tamim Bayoumi, David Ordoobadi, Blair Rourke, Anthony G. Turner, and Andrew Tweedie.
The authors of the annex are indicated on its first page. The Fiscal Analysis Division of the
Fiscal Affairs Department computed the structural budget and fiscal impulse measures.
Sungcha Hong Cha, Toh Kuan, and Michelle Marquardt provided research assistance. Shamim
Kassam, Allen Cobler, Nicholas Dopuch, Isabella Dymarskaia, Gretchen Gallik, Mandy
Hemmati, and Yasoma Liyanarachchi processed the data and managed the computer systems.
Susan Duff, Caroline Bagworth, and Margaret Dapaah were responsible for word processing.
Juanita Roushdy of the External Relations Department edited the manuscript and coordinated
production of the publication.
The analysis has benefited from comments and suggestions by staff from other IMF depart-
ments, as well as by Executive Directors following their discussion of the World Economic
Outlook on March 31 and April 2, 1997. However, both projections and policy considerations
are those of the IMF staff and should not be attributed to Executive Directors or to their na-
tional authorities.

ix
 I
Global Economic Prospects and Policies

Chart 1. World Industrial Production1

W orld economic growth quickened during 1996
following widespread deceleration of activity in
1995 (Chart 1). Economic and financial conditions are
(Percent change from a year earlier)

generally propitious for the global expansion to con- Following a marked slowdown in 1995, the pace of world industrial
activity quickened during 1996.
tinue in 1997 and the medium term at rates at least
matching those seen in the past three years (Chart 2). 20
Emerging market countries
There are few signs of the tensions and imbalances
that usually foreshadow significant downturns in the
business cycle: global inflation remains subdued, and 15
commitments to reasonable price stability are perhaps
stronger than at any other time in the postwar era; fis-
10
cal imbalances are being reduced with increasing de-
termination in many countries, which should help con- World
tain real long-term interest rates and foster higher 5
investment; and exchange rates among the major cur-
rencies appear to be generally consistent with broader
policy objectives. 0
In many countries, structural reforms are enhancing Advanced economies
the role of market forces and thereby strengthening the
basis for sustained, robust growth. The process of –5
1991 92 93 94 95 96 Jan.
trade integration continues to deepen and is being sup- 97
ported by growing liberalization of external payments.
Also, changes in the role of the state through privati- 1Data are for output in manufacturing in 30 advanced and emerging
zation and deregulation are raising efficiency and market economies representing 75 percent of world output; three-
spurring private sector activity in a growing number of month centered moving average.
successfully managed economies in all regions.
The favorable global economic conditions are un-
derscored by the continued robust growth performance
with low inflation in the United States and the United
Kingdom, the pickup in growth in Japan in 1996, and
improved prospects for a strengthening of the recover-
ies in continental Europe and Canada. In many of the
dynamic emerging market countries, there was a de-
sirable moderation of growth and inflation in 1996,
which should allow their expansions to be sustained in
the period ahead. Growth has picked up in those de-
veloping countries in the Western Hemisphere that
were particularly affected by the financial crisis in
Mexico in 1995. Activity has also strengthened in the
Middle East and Africa, while the transition countries,
as a group, are expected to register positive growth in
1997 for the first time since the collapse of central
planning.
Nevertheless, despite these grounds for optimism, it
is important to recognize that contrasts in economic
performance across countries have become starker in
recent years. There are also a number of risks to the
central scenario. First, in much of the European Union

1
 I GLOBAL ECONOMIC PROSPECTS AND POLICIES

(EU), unemployment has risen further to new postwar

peaks, and neither prospective growth nor the progress
made with labor market reforms gives reason to expect
any significant decline in joblessness in the near fu-
ture. High unemployment and weak growth could
make it difficult for EU members to fully meet the fis-
cal deficit targets associated with the plan for mone-
tary union, affect expectations about the likelihood of
the project going ahead on time, and lead to turbulence
in financial markets.
Chart 2. World Indicators1 Second, stock markets. The strength of equity prices
(In percent a year) in the United States and many other countries in the
period up to early March was a reflection of investors’
The global expansion is expected to continue with the growth of
world output and trade above trend, while inflation should remain
positive assessment of the business outlook. But re-
contained in the advanced economies and slow further in the cent declines in equity prices have underscored the
developing countries. risk of a more significant correction, especially if
12 12 earnings expectations were to be downgraded or a
Growth of World Real GDP Growth of World Trade 2 reemergence of inflationary pressures were to require
Average, 1970–96 a marked rise in interest rates. The potential for a mar-
8 8 ket correction large enough to contribute to a cyclical
Average, 1970–96 downturn depends partly on the extent to which the
rise in stock prices has been an element in a broader
4 4 buildup of demand pressures. In contrast to the run-up
in asset prices in the late 1980s, especially in Japan but
also in the United States and several other countries, a
0 0
generalized overvaluation of asset prices, leveraged by
increased indebtedness, does not appear to be present
–4 –4
in most countries with strong stock markets. Never-
1970 75 80 85 90 95 2000 1970 75 80 85 90 95 2000 theless, a significant decline in stock prices could un-
dermine confidence in some countries.
20 8 Third, capital flows to emerging market countries.
Inflation (consumer prices) World Real Long-Term
Interest The surge in such flows in recent years reflects both
Rate 3 6 the growing shift to a more open global financial sys-
15 Developing countries tem and the successful economic policies of many
(median) 4
recipient countries. But caution is warranted since
2 both the global availability of these flows and their
10 cost are vulnerable to higher global interest rates and
0
to adverse developments affecting systemically impor-
5
–2 tant capital-importing countries. While the aggregate
global flows do not seem excessive, the reliance on
–4
Advanced economies capital inflows by some countries, and the associated
0 –6 narrowing of their interest rate spreads, may not be
1970 75 80 85 90 95 2000 1970 75 80 85 90 95 2000
sustainable.
Finally, fragile banking systems are of concern in a
1Shaded areas indicate IMF staff projections. broad spectrum of countries. These problems often
2Volume of goods and services. stem from excessive credit expansion in the past under
3GDP-weighted average of ten-year (or nearest maturity) govern-
conditions of inadequate prudential supervision. In
ment bond yields less inflation rates for the United States, Japan, some emerging market countries, banking sector diffi-
Germany, France, Italy, United Kingdom, and Canada. Excluding Italy
prior to 1972. culties linked to significant exposure to foreign ex-
change risk have become more apparent following the
reversal of capital flows from abroad. Among transi-
tion countries, bank loans have often allowed enter-
prises to delay restructuring, and as a result many
firms have become increasingly unable to service their
debt. Large portfolios of nonperforming loans, the ero-
sion of banks’ capital bases, and outright banking
crises can affect countries’ economic performance by
obstructing banks’ ability and willingness to lend, by

2
 Global Economic Prospects and Policies
constraining the operation of monetary policy, and be-
cause of the budgetary costs of rescuing and restruc-
turing ailing financial institutions.
***
It is becoming increasingly clear that the benefits of
a favorable global economic environment do not ac-
crue automatically to any country. In fact, remarkable
differences persist in the degrees of success that coun-
tries have had in taking advantage of the opportunities
for strengthening their economic performance.
• Among the advanced economies, developments
have been mixed and cyclical positions differ
widely. Prospects for recovery have improved in
continental western Europe following disappoint-
ing performances in 1995 and much of 1996. But
unemployment is expected to remain at or near
record levels in France, Germany, Italy, and
several other countries. In Japan, growth was
stronger than expected in 1996, and there is up-
side potential for activity in 1997 although there
remains uncertainty in financial markets, in par-
ticular, as to whether the momentum of Japan’s
recovery will be maintained in the period ahead.
The uncertain prospects and lack of confidence
characteristic of these economies in recent years
contrast with the favorable performance of the
United States and the United Kingdom as well as
a number of smaller countries including Australia,
Denmark, Ireland, New Zealand, and the Nether-
lands. These contrasts reflect both cyclical and
structural factors, including policies.
• An increasing number of developing countries in
all regions are reaping the benefits of the stead-
fast pursuit of sound financial policies and out-
ward-oriented, market-based structural reforms.
This is reflected in large inflows of foreign direct
investment, rapid expansion of both exports and
imports, and solid growth prospects. But some
countries have experienced setbacks and others
are vulnerable to changes in investor sentiment.
While economic conditions have clearly been im-
proving in a growing number of low-income
countries, many of the poorest countries have
continued to fall behind, facing the risk of mar-
ginalization from the mainstream of global eco-
nomic progress.
• Among the transition countries, the contrasts in
performance have also widened between some of
the early, relatively successful reformers and
countries that have started adjustment and reform
later and with less determination and consistency.
Between these two extremes, which, to be sure,
also reflect widely different starting conditions,
there are wide ranges of policy effort and eco-
nomic success.
3
Motivated in part by these contrasts, the Interim
Committee in its September 1996 “Declaration on
Partnership for Sustainable Global Growth” set out a
range of broad policy principles to promote the full
participation of all economies in the global economy.
These principles stress the need to implement sound
macroeconomic policies that consolidate success in
bringing inflation down, strengthen fiscal discipline,
enhance budgetary transparency, and improve the
quality of fiscal adjustment; to foster financial and ex-
change rate stability and avoid currency misalign-
ments; to maintain the impetus toward trade liberal-
ization and current account convertibility; to tackle
labor and product market reforms more boldly; and to
ensure the soundness of banking systems and promote
good governance in all its aspects. The complementary
and mutually reinforcing roles of macroeconomic and
structural policies were given particular emphasis.1
The uneven performance across countries and un-
even distribution of rewards within them are fre-
quently linked to the phenomenon of globalization—
the rapid integration of economies worldwide through
trade, financial flows, technology spillovers, informa-
tion networks, and cross-cultural currents. There is no
doubt that globalization is contributing enormously to
global prosperity. At the same time, however, public
debate often focuses on perceived negative aspects of
globalization, including the effects on employment
and real wages, especially of the low skilled, in the ad-
vanced economies. Globalization, like any form of
technological or structural change, may adversely af-
fect the living standards of some in the short run.
However, it does not seem to be the principal force be-
hind the unfavorable developments in employment
and income distribution observed in some advanced
economies.
Another widespread perception is that globalization
may, at some cost, limit the autonomy of policymak-
ers at the national level. It is argued in this report that
while it does appear that globalization increases the
costs of economic distortions and imbalances, policy
related or otherwise, it clearly enhances the rewards
of sound policies. In this way, globalization may be
contributing to the apparent polarization between suc-
cessful countries and those that are falling behind in
relative, and sometimes even absolute, per capita in-
come positions. Globalization is not, however, a zero-
sum game with some economies winning at the ex-
pense of living standards and employment elsewhere.
If policies are adapted to meet the requirements of in-
tegrated and competitive world markets, then all
countries should be better able to develop their com-
parative advantages, enhance their long-run growth
potential, and share in an increasingly prosperous
world economy.
1See World Economic Outlook, October 1996, p. xii.
 I GLOBAL ECONOMIC PROSPECTS AND POLICIES
Globalization is not a new phenomenon. Highly
integrated markets contributed to the rapid growth
of trade and output during the period of the gold
standard prior to World War I. But two world wars,
the Great Depression, the adoption of central plan-
ning in a substantial part of the world economy, and
the pursuit of protectionist and interventionist poli-
cies in many countries seriously disrupted interna-
tional economic and financial interactions. The liber-
alization of trade and financial flows over the past
fifty years has gradually resulted in a level of integra-
tion similar in some respects to that known at the
beginning of the century—with plenty of scope for
further integration as the next century approaches.
This issue of the World Economic Outlook particu-
larly focuses on the opportunities arising from global-
ization and on how countries may best meet the chal-
lenges of a rapidly changing and highly integrated
world economy.
Advanced Economies
Recent indicators point to a moderate firming of
output growth in the advanced economies in 1997–98
following a slowdown in a number of countries, par-
ticularly in Europe, in 1996 (Table 1). Long-term in-
terest rates have come down significantly in many
countries with inflation remaining generally subdued,
and the danger of overheating has subsided in the
newly industrialized economies of Asia following pol-
icy tightenings (Box 1). External imbalances are pro-
jected to remain relatively well contained, although a
few large surplus and deficit positions may not be sus-
tainable. And exchange rates of the major currencies
appear to be reasonably consistent with fundamentals,
taking into account cyclical conditions.
Despite the many positive developments, long-
standing differences in the advanced economies’ abil-
ity to achieve and maintain high levels of employment
have become even starker in recent years. In much of
continental Europe, rates of unemployment have re-
cently risen to postwar record levels, and widespread
resort to work sharing and early retirement is not only
adding to the underutilization of labor resources but in
many cases is raising business costs and budgetary ex-
penditures. The growing imbalance between the inac-
tive population and those employed may require fur-
ther increases in already very heavy tax burdens. It
also undermines future economic growth and living
standards and threatens the viability of public pension
systems. This situation is particularly striking com-
pared with the impressive ability of the United States
to create jobs for a rapidly expanding labor force and
the progress achieved by the United Kingdom and a
number of smaller countries in reversing earlier in-
creases in trend unemployment. Addressing the mal-
functioning of labor markets has clearly become the
4
Box 1. Revised Country Classification
Beginning with the current issue of the World
Economic Outlook, a number of newly industrialized
economies in Asia (Hong Kong, Korea, Singapore,
and Taiwan Province of China), as well as Israel, are
considered together with the group of countries tradi-
tionally known as industrial countries. The reclassifi-
cation reflects the advanced stage of economic devel-
opment these economies have now reached. In fact,
they all now share a number of important industrial
country characteristics, including per capita income
levels well within the range indicated by the group of
industrial countries, well-developed financial markets
and high degrees of financial intermediation, and di-
versified economic structures with relatively large
and rapidly growing service sectors. Rather than re-
taining the old industrial country label, the expanded
group is labeled the “advanced economies” in recog-
nition of the declining share of employment in manu-
facturing common to all of these economies.
most pressing economic policy issue of the late 1990s
for many advanced economies.
Both macroeconomic and structural policies need to
be strengthened to improve growth and labor market
performance. For fiscal policy, as discussed below, the
priority remains the need to further reduce budgetary
imbalances, which are still excessive in many cases.
This is a key requirement for restoring higher sustain-
able rates of economic growth in the medium term. As
discussed in the May 1996 World Economic Outlook,
the short-term effects on output and employment of
fiscal consolidation depend partly on the composition
of fiscal adjustment measures. Also, in countries with
unsustainable fiscal imbalances credible steps to im-
prove the fiscal outlook can have positive effects on
confidence and activity relatively quickly. Normally,
some short-run costs tend to be associated with imple-
menting budgetary retrenchments, but progress toward
fiscal consolidation and the achievement of reasonable
price stability provide added scope for monetary pol-
icy to support activity in countries with significant
margins of slack. This has been generally recognized
by monetary authorities, which have appropriately
eased official interest rates to support demand when
price stability would not seem to be threatened. Even
so, official interest rates could have been adjusted
more rapidly in some European countries in recent
years in response to widespread signs of cyclical
weakness, without compromising the credibility of
monetary policy. This would have helped to put the re-
covery on a stronger footing.
The greatest need for policy action to strengthen
Europe’s economic performance is in the structural
area (which is also true of Japan, as discussed below).
 Advanced Economies

Table 1. Overview of the World Economic Outlook Projections

(Annual percent change unless otherwise noted)

Differences from
Current October 1996
Projections
______________ Projections
_______________
1995 1996 1997 1998 1996 1997
World output 3.7 4.0 4.4 4.4 — 0.2
Advanced economies 2.5 2.5 2.9 2.9 — 0.1
Major industrial countries 2.0 2.2 2.6 2.6 — 0.1
United States 2.0 2.4 3.0 2.2 — 0.6
Japan 1.4 3.6 2.2 2.9 — –0.5
Germany 1.9 1.4 2.3 3.0 0.1 –0.1
France 2.2 1.3 2.4 3.0 0.1 —
Italy 3.0 0.7 1.0 2.4 –0.4 –1.2
United Kingdom 2.5 2.1 3.3 2.8 –0.1 0.4
Canada 2.3 1.5 3.5 3.4 0.1 0.3
Other advanced economies 4.2 3.7 3.8 4.1 — –0.1
Memorandum
Industrial countries 2.1 2.3 2.7 2.7 — 0.2
European Union 2.5 1.6 2.4 2.9 — –0.1
Newly industrialized Asian economies 7.4 6.3 5.7 6.1 –0.3 –0.9
Developing countries 6.0 6.5 6.6 6.5 0.2 0.5
Africa 2.9 5.0 4.7 4.8 — –0.4
Asia 8.9 8.2 8.3 7.7 0.2 0.7
Middle East and Europe 3.8 4.5 3.9 3.9 0.7 0.6
Western Hemisphere 1.3 3.5 4.4 5.1 0.5 0.5
Countries in transition –0.8 0.1 3.0 4.8 –0.7 –1.0
Central and eastern Europe 1.6 1.6 3.0 4.7 –0.5 –1.2
Excluding Belarus and Ukraine 5.0 3.4 3.3 4.7 –0.8 –1.4
Russia, Transcaucasus, and central Asia –4.0 –1.9 3.0 4.9 –0.9 –0.8
World trade volume (goods and services) 9.2 5.6 7.3 6.8 –1.1 0.2
Imports
Advanced economies 8.7 5.3 5.9 6.1 –0.5 –0.1
Developing countries 11.6 8.3 10.7 8.4 –2.9 0.6
Countries in transition 15.9 7.7 9.8 6.8 –4.2 1.8
Exports
Advanced economies 8.4 5.0 6.9 6.7 –0.2 0.2
Developing countries 11.2 7.0 11.0 8.0 –3.3 0.5
Countries in transition 13.5 4.7 6.9 7.0 –5.8 1.1
Commodity prices
Oil 1
(In SDRs) 1.9 24.3 1.4 –6.4 6.4 9.0
(In U.S. dollars) 8.0 18.9 –3.6 –6.7 5.8 4.0
Nonfuel2
(In SDRs) 2.1 3.1 5.2 0.1 –1.7 7.7
(In U.S. dollars) 8.2 –1.3 — –0.3 –1.9 2.5
Consumer prices
Advanced economies 2.6 2.4 2.5 2.5 — –0.1
Developing countries 21.3 13.1 9.7 8.5 –0.2 –1.1
Countries in transition 119.2 40.4 30.7 11.6 1.4 14.1
Six-month LIBOR (in percent)3
On U.S. dollar deposits 6.1 5.6 6.0 6.1 — —
On Japanese yen deposits 1.3 0.7 1.0 2.8 –0.3 –1.4
On deutsche mark deposits 4.6 3.3 3.3 3.8 — –0.5

Note: Real effective exchange rates are assumed to remain constant at the levels prevailing during
March 1–18, 1997, except for the bilateral rates among ERM currencies, which are assumed to remain con-
stant in nominal terms.
1Simple average of spot prices of U.K. Brent, Dubai, and West Texas Intermediate crude oil. The aver-
age price of oil in U.S. dollars a barrel was $20.42 in 1996; the assumed price is $19.69 in 1997 and $18.36
in 1998.
2Average, based on world commodity export weights.
3London interbank offered rate.

5
 I GLOBAL ECONOMIC PROSPECTS AND POLICIES
There has been some progress in reforming the com-
plex web of regulations, benefits, and taxes that dis-
courage job creation and job search, but efforts to date
have been piecemeal and inadequate in many cases.
Opposition to more comprehensive reforms stems
from fears that changes in Europe’s social welfare sys-
tem would reduce job security, widen wage differen-
tials, and threaten living standards. Mounting evidence
that labor market regulations and high benefit levels
are major contributing factors to high and persistent
unemployment, excessive tax burdens, chronic fiscal
imbalances, and lack of economic dynamism is too
often ignored.
It is therefore essential to strengthen the public’s un-
derstanding of the economic forces that are at work. At
the same time, there is a continued need to persevere
with comprehensive reforms to reduce overly gener-
ous levels of unemployment compensation, tighten el-
igibility criteria, reduce taxes on employment, and fa-
cilitate not only job search and training but also
restructurings and layoffs—and thereby hirings. Such
reforms would allow market forces a greater role in
helping to clear the labor market at much lower levels
of unemployment. Tax and transfer systems also will
need to be reformed so that they may better meet eq-
uity objectives and safeguard a reasonable level of so-
cial protection without the negative implications for
incentives and employment that are clearly associated
with present arrangements. Reducing unemployment
would in itself alleviate a major source of income in-
equality and social exclusion.
To what extent can the difficulties in labor markets
in the advanced economies—whether in the form of
unemployment or widening wage differentials—be at-
tributed to pressures from globalization? As discussed
in this World Economic Outlook, there is little indica-
tion that increased trade with low-cost countries has
contributed significantly to the declining share of em-
ployment in manufacturing, which is the principal
tradable goods sector. Nor does it seem to explain
much of the relative decline of low-skilled wages. The
claim that these phenomena stem from globalization
and could be alleviated through trade protection and
other inward-looking policies does not appear to be
supported by the evidence. The relative decline of em-
ployment in manufacturing has occurred in spite of
relative stability in the distribution of expenditures
between manufactures and services at constant prices;
it seems attributable mainly to the relatively rapid
growth of labor productivity in manufacturing, as a re-
sult of technical progress and the normal process of
capital deepening. Although the share of manufactur-
ing employment has been declining in these coun-
tries—a development referred to as deindustrializa-
tion—the trend of industrial output remains positive in
most of them.
As economies mature, it seems likely that the share
of employment in industry will continue to fall while
6
the importance of services increases further. However,
whereas many service industries attract highly quali-
fied labor into well-paid jobs, some service jobs are in
activities with low value added and paying corre-
spondingly low relative wages. This is one of the ways
in which technological change appears also to have af-
fected wage differentials. The precise mix of service
jobs created, however, is likely to depend on the qual-
ity of the labor available. Better education and train-
ing, therefore, should be of high priority in dealing
with both the unemployment problem and the ten-
dency for wage differentials to widen as technical
progress demands new skills. In many countries, gov-
ernments are appropriately pursuing policies whereby
those who benefit the most from these developments
contribute to the assistance of those less well posi-
tioned. However, in designing such policies it is im-
portant to avoid creating poverty traps while promot-
ing incentives to enhance skills and to seek out better
employment opportunities.
The need for fiscal consolidation is another key pol-
icy priority in many advanced economies. There has
been welcome progress in many cases and structural
fiscal imbalances have been brought down, on aver-
age, from 3!/2 percent of GDP in 1990 to about 2 per-
cent of GDP in 1996. Nevertheless, fiscal imbalances
are still excessive in a large number of countries, with
the prospective aging of populations and the attendant
pressures on health and pension outlays adding to the
urgency of fiscal reforms. The need to restore and
safeguard sound public finances has led a number of
countries to consider introducting codes of fiscal
transparency as exemplified by New Zealand’s Fiscal
Responsibility Act and the Charter of Budget Honesty
that is expected to be enacted in Australia. Similar
concerns have stimulated interest in rules for the con-
duct of fiscal policy, as reflected in the Stability and
Growth Pact that has now been agreed among mem-
bers of the European Union, and the discussions of
balanced budget constitutional amendments in the
United States and Switzerland.
The introduction of fiscal rules is one approach to
achieving greater fiscal discipline and to avoiding the
“deficit bias” that has emerged from discretionary pol-
icy or from the unintended consequences of social in-
surance programs adopted under more favorable eco-
nomic circumstances. Sustained and committed efforts
to contain fiscal imbalances through discretionary ac-
tions could equally achieve the same objective.
Opponents of fiscal rules argue that they could unduly
constrain the conduct of fiscal policy during cyclical
downturns. But this does not need to be the case. In
fact, the increased discipline involved in the adherence
to such rules may well permit a greater stabilizing role
for fiscal policy than has been possible in most coun-
tries for a long time. It is of course essential that fiscal
rules be well designed and provide reasonable room to
accommodate cyclical fluctuations. A requirement to
 Advanced Economies
balance revenues and expenditures every year would
necessitate immediate adjustments of the level of out-
lays or taxes in response to cyclical variations in rev-
enue and expenditure, which would be neither feasible
nor desirable. Moreover, to be effective, any fiscal rule
would need to be supported by increased transparency
of off-budget transactions, unfunded pension liabili-
ties, and other future commitments.
The year 1997 is especially important for Europe—
the test year for deciding, by the spring of 1998, which
members of the EU meet the criteria for initial partic-
ipation in the planned Economic and Monetary Union
(EMU). This project has already achieved much, no-
tably in terms of promoting a sustained decline in in-
flation and an impressive start on fiscal consolidation.
Public sector deficits, which averaged 6.5 percent of
GDP in 1993, had been reduced to 4.4 percent of GDP
by last year, when 6 of the 15 members were in com-
pliance with the 3 percent reference value for budget
deficits that forms part of the eligibility criteria for
participation in EMU. Indeed, had it not been for the
relatively large output gaps, it is estimated that all but
four of the members would have met that reference
value last year (Chart 3). Despite continuing output
gaps, virtually all members are aiming to satisfy the
deficit criterion in 1997, and a fortiori in 1998 and be-
yond. The policy achievements that have been accom-
plished set the stage for stronger economic perfor-
mance in the future. But the run-up to EMU is
nonetheless exacting a toll, both because of the short-
term consequences of fiscal consolidation and also by
contributing to uncertainties and hesitancies in busi-
ness and consumer confidence that have fed back into
demand and activity. It is critical to get through this
period promptly by bringing the project to term within
the agreed time frame. To this end, governments need
to continue to follow through on their policy commit-
ments and objectives, in both the fiscal and structural
areas. A strong foundation is being laid, and it is time
to begin to reap the fruits.
The EMU project reflects the political will to forge
ever-closer links among the member countries of the
EU. From an economic perspective, the attractiveness
of monetary union includes the prospect of greater
economic and financial stability among the partici-
pants, associated with a strong commitment to price
stability, to be implemented by one independent cen-
tral bank, and increased efforts to achieve and safe-
guard fiscal balance. This should help contain real in-
terest rates, especially in countries where risk
premiums have been high. In addition, the monetary
union is likely to foster deeper capital market integra-
tion in Europe and help increase efficiency in financial
markets. The introduction of a single currency will
also eliminate the potential for tensions to develop
among the members’ currencies, which in the past
have often accentuated the effects of asymmetric eco-
nomic and financial disturbances.
7
Of course, disturbances may still affect countries
unevenly, and a need to promote a smooth adjustment
to such shocks will remain. Since monetary policy will
be determined by areawide considerations, fiscal pol-
icy will have to play some role, subject to the con-
straints agreed in the framework of the Stability and
Growth Pact. In some instances, financial assistance
from the EU budget may be warranted, as indicated in
the Maastricht Treaty, to help a country address severe
difficulties caused by exceptional occurrences beyond
its control. Most critical for the success of the EMU
project, and for the dynamism of the European
economies, is the need to improve the functioning of
European labor markets. From this perspective, most
members of the EU must strive to make much more
progress irrespective of their plans to participate.
Changes in the exchange rates among the major cur-
rencies during the past 18 months have been generally
consistent with underlying fundamentals and relative
cyclical positions and constitute a substantial correc-
tion of the misalignments of spring 1995. These ex-
change rate changes are a reflection of, and are help-
ing to reinforce, the policy stances that are needed
from a cyclical perspective—in the United States and
the United Kingdom to restrain inflationary pressures,
and in Japan, Germany, and France to support fragile
recoveries. However, they should not be viewed as
fully substituting for adjustments of monetary policies
that may be needed for domestic reasons. Over the
medium term, some of the recent appreciation of the
dollar and depreciation of the yen may not be compat-
ible with further reduction of external imbalances, and
these currency movements may be reversed as cyclical
positions become less uneven.
***
With regard to prospects and policies in individual
countries, the United States has been remarkably suc-
cessful in maintaining a high level of employment
while reducing its fiscal deficit and safeguarding low
inflation. The economy expanded by 2!/2 percent in
1996, and price pressures remained subdued despite
high resource utilization, including a tight labor mar-
ket. In 1997, real GDP is expected to increase by
3 percent, somewhat faster than envisaged in the
October 1996 World Economic Outlook. To reduce the
risk of rising inflation the Federal Reserve raised
short-term rates slightly in late March. Given the
strong underlying growth momentum, a moderate fur-
ther firming of monetary conditions may soon be
needed and is assumed in the forecast (the policy as-
sumptions underlying the projections are set out in
Box 2). Continued efforts are also needed to balance
the budget over the medium term and to avert a rise in
the deficit in the longer run due to the rapid growth in
spending on pensions and medical care for the elderly.
Enhancing national saving performance through a
stronger fiscal position would help sustain future
 I GLOBAL ECONOMIC PROSPECTS AND POLICIES

Chart 3. European Union: General Government Budget Positions1

(In percent of GDP)

Expected progress toward reducing underlying budgetary imbalances is masked to some extent by large
cyclical components in fiscal deficits.

1996
97 Greece
98
1996
97 France 2
98
1996
97 Germany
98
1996
97 Italy3
98
Unadjusted 1996
97 Spain
98
Structural 1996
97 United Kingdom
98
1996
97 Portugal
98
1996
97 Belgium
98
1996
97 Austria
98
1996
97 Netherlands 4
98
1996
97 Finland
98
1996
97 Ireland 4
98
1996
97 Sweden 5
Maastricht Treaty 98
reference value 1996
97 Denmark 5
98
1996
97 Luxembourg 6
98
1996 European Union
97
98
(Average) 7
–8 –7 –6 –5 –4 –3 –2 –1 0 1 2

1The detailed assumptions underlying the fiscal projections are set out in Box 2. The ordering of countries is based on the
projected unadjusted budget positions in 1997, except that where the differences between projections are not significant the or-
dering is alphabetical.
2The projection for 1998 is based on the assumption that, in the absence of official measures, most categories of primary
expenditures will increase in line with potential output. Therefore, it does not take into account the planned decrease in gen-
eral government financing needs of 0.65 percent of GDP for 1998 (i.e., the same target as for 1997) that the French authorities
have officially announced. Full implementation of the government’s policy intentions would yield a deficit below 2.9 percent
of GDP.
3The projection for 1998 is made on a “current services” (tendenziale) basis. It therefore does not take into account any pos-
sible effects of the announced review of pension and welfare spending.
4The unadjusted budget positions for Ireland and the Netherlands are not shown separately because they are about equal to
the structural balance, given that output is estimated to be close to potential in both countries.
5The unadjusted budget position for Sweden is projected to show a surplus of 0.3 percent of GDP in 1998. Denmark’s un-
adjusted budget position is projected to be in balance in 1998.
6Structural budget positions are unavailable and unadjusted budget positions are expected to be in approximate balance in
1996–98.
7Excludes Luxembourg.

8
 Advanced Economies
growth. It would also be the best way, from both a do-
mestic and global perspective, to address the chronic
external deficit.
In Canada, after a disappointing performance in
1995 and early 1996, economic activity picked up in
the second half of last year; unemployment has begun
to decline, and the economy is poised for solid growth
in 1997 and 1998. The general government fiscal
deficit, which reached 7!/2 percent of GDP in 1992, has
been reduced progressively and is expected to disap-
pear next year. This has helped restore financial mar-
ket confidence, which together with subdued inflation
has allowed official interest rates to be reduced well
below U.S. money market rates without undermining
the credibility of the authorities’ commitment to price
stability or weakening the exchange rate.
The recovery in Japan became more broadly based
in 1996 and the economic climate improved under the
influence of supportive fiscal and monetary policies
and a correction of the excessive appreciation of the
yen through the spring of 1995. GDP growth picked
up in the fourth quarter reflecting strong domestic de-
mand as well as the effects of yen depreciation on net
exports. Easy monetary conditions and improving
labor market conditions are expected to underpin con-
tinued recovery at a moderate underlying pace in
1997. Although there is potential for growth to turn out
stronger than expected, uncertainties remain about the
impact of fiscal consolidation measures and the effects
of strains in the financial system. Thus monetary pol-
icy will need to remain easy until an autonomous re-
covery is firmly established. Fiscal consolidation
should proceed at a sustained pace without undermin-
ing prospects for continued recovery.
The sluggish performance of the Japanese economy
in recent years reflects not only weak demand related
partly to financial sector difficulties but also the lack
of progress in many areas of structural reform. This is
apparent in the divergences that have built up over
time between the performances of the tradable and
nontradable goods sectors. The latter have remained
overregulated, subject to a low degree of competition,
relatively inefficient, and characterized by very high
cost and price levels. As in other mature economies,
however, the tradable goods sector accounts for a de-
clining share of total employment so that jobs and liv-
ing standards increasingly have to be supported by
more dynamic service sectors. It will therefore be im-
portant to translate quickly into substantive reforms
the growing consensus on the need for further
deregulation.
In both Germany and France, growth slowed to
about 1!/2 percent in 1996 and is expected to be in the
range of 2–2!/2 percent in 1997. In Germany, strong
exports should eventually spill over into domestic de-
mand, which will also benefit from lower interest
rates. M3, the principal monetary aggregate monitored
by the Bundesbank, has expanded relatively strongly.
9
However, confidence indicators are still quite mixed,
unemployment has risen to postwar records, and the
pace of fiscal consolidation is set to strengthen in
1997. In the structural area, Germany is confronted
both with the need to enhance the flexibility of its
labor and product markets and with the special chal-
lenges posed by the dependence of the eastern Länder
on transfers and subsidies. In France, the business cli-
mate has improved somewhat, but consumer confi-
dence is still weak, and the projected pickup in busi-
ness investment seems fragile. Moreover, it remains
necessary to implement more comprehensive labor
market, tax, and public sector reforms in order to fos-
ter job creation and entrepreneurship.
Short-term interest rates have been reduced consid-
erably in both Germany and France to help offset re-
cessionary forces. In combination with the absence of
inflationary pressures, and the recent helpful depreci-
ation of the deutsche mark and the franc against the
U.S. dollar and some other European currencies, the
easing of monetary conditions has helped to contain
long-term interest rates in the face of higher bond
yields in the United States. All these developments
provide good reasons to expect the recovery to gain
some momentum. While there is upside potential,
however, there remain downside risks, and it is too
early to conclude that the process of monetary easing
has fully run its course.
In Italy, after relatively strong growth in 1995, re-
covery stalled in 1996 and activity is now expected to
remain subdued in 1997, mainly owing to an accel-
erated pace of fiscal consolidation and the lagged ef-
fects of the lira’s appreciation. Considerable progress
has been made in reducing inflation to the levels of
Italy’s EU partners and in strengthening the credibility
of the authorities’ commitment to reduce the budget
deficit. This contributed in 1996 to a marked narrow-
ing of the premium in long-term interest rates over
those of Germany and to the correction of the earlier
excessive depreciation of the lira, which permitted its
return to the European exchange rate mechanism
(ERM) in November. Lower debt-servicing costs and
the strengthening of fiscal plans, including the recent
additional package, are expected to bring the fiscal
deficit close to the Maastricht reference value in 1997.
The authorities have announced the start of a thorough
review of pension and welfare spending, which should
help ensure that the progress recorded to date is sus-
tained in 1998 and beyond.
The United Kingdom’s solid upswing, now in its
fifth year, is expected to continue in 1997 on the
strength of consumption and a projected pickup in
business investment. The recent appreciation of ster-
ling is helping to dampen inflationary pressures and
seems to pose no immediate threat to the expansion,
but the forces supporting growth may be tilting too
much toward domestic demand. Wage increases have
picked up as unemployment has continued to fall, and
 I GLOBAL ECONOMIC PROSPECTS AND POLICIES
Box 2. Policy Assumptions Underlying the Projections
Fiscal policy assumptions for the short term are based
on official budgets adjusted for any deviations in outturns
as estimated by IMF staff and also for differences in eco-
nomic assumptions between IMF staff and national au-
thorities. The assumptions for the medium term take into
account announced future policy measures that are
judged likely to be implemented. Both short-term and
medium-term projections are based on information avail-
able up to the end of March 1997. In cases where future
budget intentions have not been announced with suffi-
cient specificity to permit a judgment about the feasibil-
ity of their implementation, an unchanged structural pri-
mary balance is assumed, unless otherwise indicated. For
selected advanced economies, the specific assumptions
adopted are as follows (see Tables 4–5, and A15–A16 in
the Statistical Appendix for the projected implications of
these assumptions).
United States: For the period through FY 1999, fiscal
revenues and outlays at the federal level are based on the
administration’s February 1997 budget proposal, after ad-
justing for differences between the IMF staff’s macro-
economic assumptions and those of the administration.
For FY 2000 onward, the federal government’s structural
primary balance as a proportion of GDP is assumed to re-
main unchanged from its projected FY 1999 level.
Japan: The projections take account of policies an-
nounced in the 1997 budget, in particular an increase in
the consumption tax rate from 3 percent to 5 percent and
an end to the temporary income tax cut. Reflecting likely
moves toward fiscal consolidation, public investment is
assumed to total ¥570 trillion between FY1995 and 2004,
rather than the ¥630 trillion assumed in the medium-term
public investment plan and earlier WEO projections. The
projections assume that the 1994 pension reform plan is
fully implemented.
Germany: The 1997 revenue and expenditure projec-
tions take into account the effects of the government’s
consolidation package (comprising measures at the fed-
eral, state, and local levels, and the social security funds)
and the 1997 Tax Act as passed by parliament in
December. The difference with the official deficit projec-
there is a risk that inflation will again exceed the au-
thorities’ target (of 2!/2 percent or below) in 1998 and
beyond unless further action is taken to rein in de-
mand. This would need to be achieved in the first in-
stance through an early tightening of monetary policy.
While the fiscal deficit has been reduced substantially
in recent years, the November budget tightened the
fiscal stance only slightly further in the near term, and
more fiscal action is needed to help restrain demand
and alleviate the burden on monetary policy.
Many of the smaller advanced economies have en-
joyed robust growth in recent years and several have
10
tion of 2.9 percent is mainly due to a slightly less san-
guine view of the macroeconomic environment, the fi-
nancial position of social security funds, and tax rev-
enues; it also reflects available information on fiscal
developments so far in 1997. In 1998, and over the
medium term, IMF staff projections assume an un-
changed structural primary balance.
France: Budget projections for 1997 reflect the gov-
ernment’s plans for the state budget (a freeze of nominal
expenditure, some income tax relief, and a special transfer
from France Télécom) and assume that the social security
expenditure ceilings will be respected. The blocking of
F 10 billion in state expenditure announced in early March
is also included, as is the expected deterioration in the fi-
nances of the unemployment insurance fund. For 1998, it
is assumed that the ratio of revenue to GDP drops by 0.3
of 1 percentage point (the revenue ratio in 1997 having
been boosted by the special transfer mentioned above) and
that most categories of primary expenditure grow in line
with potential output. For the medium term, the projec-
tions assume an unchanged structural primary balance.
Italy: The projections take into account measures that
have already been implemented as part of the 1997 bud-
get and the supplementary “effort for Europe,” as well as
the additional package announced in March 1997. In the
absence of an updated plan for 1998–99 following the
strengthening of the 1997 effort, the projections for those
years are made on a current services (tendenziale) basis
and reflect also the phased resumption of tax refund pay-
ments postponed from 1997. Projections beyond 1999 are
based on an unchanged structural balance.
United Kingdom: The budgeted three-year spending
ceilings are assumed to be observed. Thereafter, non-
cyclical spending is assumed to grow in line with poten-
tial GDP. For revenues, the projections incorporate,
through the three-year budget horizon, the announced
commitment to raise excises on tobacco and road fuels
each year in real terms; thereafter, real tax rates are as-
sumed to remain constant.
Canada: Federal government outlays for departmental
spending and business subsidies are assumed to conform
taken measures to reduce the risk of overheating, gen-
erally with considerable success. In fact, official inter-
est rates in Australia have declined recently in re-
sponse to moderating inflation. Korea and Singapore
experienced a moderation of growth in 1996 as a result
of a slowdown in exports and, in Korea, some policy
tightening. With the transfer of sovereignty over Hong
Kong to China proceeding smoothly, and apart from
the short-term effects of labor unrest in Korea, the
prospects for the newly industrialized economies in
Asia remain bright, even though their future growth
may be somewhat slower than the rapid pace of catch-
 Advanced Economies
to the medium-term commitments announced in the
February 1997 budget. Other outlays and revenues are as-
sumed to evolve in line with the IMF staff’s projected
macroeconomic developments. The projections include a
contingency reserve for 1997/98 through 1998/99 and as-
sume a reduction of 10 cents in the employment insurance
premium in 1998/99 and a reduction of 5 cents a year
thereafter. The fiscal situation of the provinces is assumed
to be consistent with their stated medium-term targets.
Australia: Projections are based on the Commonwealth
government’s 1996–97 midyear economic and fiscal out-
look, adjusted for any differences between the economic
projections of the IMF staff and the authorities.
Unchanged policies are assumed for the state and local
government sector from 1997.
Belgium: The 1997 projections are based on the 1997
budget and the IMF staff’s macroeconomic projections;
an allowance is made for some slippage in social security
expenditure, but this is offset by lower-than-budgeted in-
terest payments. For 1998, the decline in the deficit re-
flects mainly lower interest payments and a partial clos-
ing of the output gap. Beyond 1998, the structural
primary balance is assumed unchanged.
Israel: The fiscal assumptions are in line with the gov-
ernment’s medium-term fiscal plan, which establishes an-
nual targets for the budget deficits until 2001.
Korea: Projections for 1997–2002 assume that the cen-
tral government budget remains broadly in balance and
that small surpluses continue to be recorded at the general
government level.
Netherlands: The 1997 projections are based on the
1997 budget and IMF staff estimates for interest rates and
economic activity; they assume that a portion of the
higher-than-anticipated revenues recorded in 1996 was
structural in nature. The 1998 projections reflect the gov-
ernment’s expenditure norm, with no further tax cuts.
Beyond 1998, the structural primary balance is assumed
constant.
Spain: Fiscal projections for 1997 assume that the bud-
get is implemented as passed by parliament but allow for
ing up sustained in the past. In Israel, which has also
been grappling with overheating, the planned tighten-
ing of the fiscal stance is needed to relieve the burden
on monetary policy, reduce the external deficit to a
more sustainable level, and help bring inflation into
the low single digits typical of other advanced
economies. In Europe, Ireland and Norway are ex-
pected to continue to expand rapidly. In both cases,
vigilance is needed to prevent overheating; invest-
ments abroad through Norway’s “petroleum fund”
should help reduce upward pressure on the krone as-
sociated with large oil revenues. In Denmark and the
11
differences in macroeconomic assumptions and some ex-
penditure overruns that are partially offset by lower in-
terest payments. For 1998 and beyond, it is assumed that
there is no major change in tax policy, the wage freeze
ends, public sector wages grow at roughly the rate of in-
crease of wages in the private sector, and goods and ser-
vices purchases remain constant as a share of GDP.
Sweden: The medium-term projections are based on
the government’s multiyear consolidation program ap-
proved by parliament in 1995 and augmented by addi-
tional measures incorporated into the 1997 budget.
Switzerland: Projections for 1997–2000 are based on
official estimates for current services. Thereafter, the
general government structural primary balance is as-
sumed to remain constant.
***
Monetary policy assumptions are based on the estab-
lished framework for monetary policy in each country,
which in most cases implies a nonaccommodative stance
over the business cycle. It is generally assumed that of-
ficial interest rates will firm when economic indicators
suggest that inflation will rise above its acceptable rate
or range and ease when indicators suggest that pro-
spective inflation will not exceed the acceptable rate
or range, that prospective output growth is below its po-
tential rate, and that the margin of slack in the economy
is significant. For the exchange rate mechanism (ERM)
countries, which use monetary policy to adhere to ex-
change rate anchors, official interest rates are assumed to
move in line with those in Germany, except that progress
on fiscal consolidation may influence interest differen-
tials relative to Germany. On this basis, it is assumed that
the London interbank offered rate (LIBOR) on six-
month U.S. dollar deposits will average 6 percent in
1997 and 6.1 percent in 1998; on six-month Japanese
yen deposits, it will average 1.0 percent in 1997 and
2.8 percent in 1998; and on six-month deutsche mark de-
posits, 3.3 percent in 1997 and 3.8 percent in 1998.
Changes in interest rate assumptions compared with the
October 1996 World Economic Outlook are summarized
in Table 1.
Netherlands also, action may be needed to contain rel-
atively buoyant domestic demand; because of the con-
tinued easy monetary stance warranted in Germany,
fiscal policy should provide the necessary degree of
restraint in both of these ERM countries.
In other EU countries, where margins of slack are
still significant, fiscal consolidation is helping to re-
lieve the burden on monetary policy and is improving
the economic outlook. In Spain, thanks also to an im-
pressive drop in inflation, both short-term and long-
term interest rates have come down sharply. In Sweden
and Finland, solid recoveries from serious downturns
 I GLOBAL ECONOMIC PROSPECTS AND POLICIES
early in the decade are set to continue, supported by
subdued inflation, improving fiscal positions, and a
marked narrowing of interest differentials vis-à-vis
Germany. Activity has also picked up in Austria,
Belgium, and Portugal. Outside the EU, there are still
no clear signs of recovery in Switzerland from a pro-
tracted recession that left the economy stagnant in
1996 for the sixth successive year. However, an easier
monetary stance and correction of the earlier excessive
appreciation of the Swiss franc have improved the
prospects for a turnaround.
Developing Countries
In the developing countries as a group, growth
picked up to 6!/2 percent last year from 6 percent in
1995, as stronger activity in Africa, Latin America,
and the Middle East offset a moderate slowdown in
parts of Asia. Data on trade and industrial production
indicate that aggregate activity slowed in the course of
1995 but picked up speed again during 1996. The ap-
parent synchronization of the developing countries’
business cycle in 1995–96 with that of the advanced
economies contrasts with the experience of the early
1990s when the buoyancy of developing country
growth helped maintain global expansion while many
advanced economies suffered recessions (see Chart 1).
The recent abatement of overheating pressures in
many of the most successful developing countries has
enhanced the chances of their expansions being sus-
tained, and the growth projection for the developing
countries overall in 1997 has been marked up to
6!/2 percent.
The Mexican economy is continuing to recover fol-
lowing the 1995 crisis, and the return of financial mar-
ket confidence has allowed Mexico to prepay a sub-
stantial part of the emergency loans obtained in support
of its adjustment efforts. The expansion is expected to
maintain its momentum in 1997 provided financial
policies and structural reforms remain on track. The re-
covery in Argentina is also expected to continue in
1997, with inflation remaining close to zero. In Brazil,
growth strengthened in 1996 while inflation fell to 9 per-
cent by the end of the year, the lowest in three and a
half decades. But a widening deficit on current account
and a policy mix characterized by a weak fiscal stance
and tight monetary conditions carry risks. In Chile, the
most successful economy in the region, inflation fell to
a 36-year low of 6!/2 percent at the end of 1996, and de-
mand pressures have eased in response to tighter mon-
etary policies. Output growth remains strong, however,
and the external deficit, affected by the decline in cop-
per prices, is quite large so that further restraint may be
warranted. To avoid stimulating capital inflows, fiscal
policy should provide the bulk of this restraint.
Among the developing countries in Asia, those that
have had to deal with risks of overheating have gener-
12
ally been successful in dampening the growth of
domestic demand. The slowdown in the region’s ex-
port growth in 1996 helped to contain inflationary
pressures, although it has exacerbated external imbal-
ances in some cases. Thailand saw a significant slow-
down in growth in 1996, largely as a result of a disap-
pointing export performance; concerns about the large
current account deficit as well as fragilities in the fi-
nancial system have given rise to exchange market
pressures in recent months. Malaysia appears to have
weathered the slowdown in foreign demand relatively
well; the possibility of a rebound in demand pressures
in 1997, as well as concerns about asset-price infla-
tion, warrant a cautious policy stance. In Indonesia,
inflation has begun to diminish and growth has slowed
moderately; the reliance on foreign saving will need to
be contained through a stronger fiscal position. The
Philippines saw a further strengthening of economic
performance in 1996 and is expected to continue to
reap the fruits of its intensified stabilization and re-
form efforts.
Like many other rapidly growing economies in Asia,
China has taken measures to reduce overheating, and
real GDP growth moderated to just under 10 percent in
1996 with retail price inflation slowing further to 6 per-
cent, down from 22 percent in 1994. The soft landing
has set the stage for continued expansion, but sustain-
ing rapid growth with low inflation will require tangi-
ble progress in restructuring and raising efficiency in
state enterprises (including by diversifying ownership),
addressing weaknesses in the financial sector, and en-
hancing budget revenue. The strong external sector
provides the opportunity to accelerate significantly the
process of trade liberalization, which is critical for
China to benefit fully from the recent and welcome im-
plementation of current account convertibility.
India’s quite strong expansion moderated somewhat
in 1996, and inflation also slowed, as a result of both
policy measures and a marked slowing of export
growth in line with trends in the rest of Asia. In 1997,
growth is expected to be sustained at a moderate pace,
helped by the easing of monetary policy since mid-
1996, but limited progress in reducing the fiscal deficit
remains a risk for inflation and a constraint on growth.
Further trade liberalization, reform of domestic prod-
uct markets, and enterprise reform are needed to put
India on a higher sustainable growth path. In Pakistan,
which experienced severe balance of payments diffi-
culties in late 1996, there is a continued need for
strong stabilization measures and a wide range of
structural reforms.
Growth in the Middle East and Europe region in
1996, at 4!/2 percent, was stronger than expected,
partly as a result of economic reforms introduced in
recent years, but also reflecting the higher-than-pro-
jected level of oil prices. For 1997, expected output
growth has also been marked up. The temporary char-
acter of the recent tightness in oil markets underscores
 Developing Countries
the continued need for structural reforms to lessen the
dependence on oil revenues and enhance long-term
growth prospects. Higher oil revenues and public ex-
penditure restraint contributed to an improvement in
economic conditions in Saudi Arabia last year, which
is expected to continue in 1997. In Egypt, recent ac-
tions to consolidate macroeconomic stabilization and
deepen the process of structural reform should
strengthen growth further and promote the reorienta-
tion of the economy. Jordan is setting a prominent ex-
ample in the region through its progress with stabi-
lization and reform policies as underscored by
declining internal and external imbalances, low infla-
tion, and robust economic growth. In contrast, the
economic outlook in Turkey remains subject to signif-
icant downside risks owing to lax fiscal and monetary
policies and rampant inflation.
Africa’s growth performance in 1996 was particu-
larly encouraging: real GDP is estimated to have risen
by about 5 percent, the strongest growth rate in
20 years, and nearly twice the average growth rate ob-
served since the early 1970s. There are signs that the
implementation of stronger macroeconomic and struc-
tural policies and improvements in governance have
begun to produce higher growth in an increasing num-
ber of countries. For example, Benin, Côte d’Ivoire,
Senegal, and other CFA franc zone countries are see-
ing continued recovery following the adjustment to a
more realistic exchange rate since 1994 and the adop-
tion of appropriate reforms. Ghana, Kenya, Malawi,
and Uganda are also achieving growing success from
allowing market forces a greater role in an environ-
ment of macroeconomic discipline. In South Africa,
downward pressure on the exchange rate emerged in
1996, while growth, at 3 percent, was somewhat
weaker than expected. Sustained reform and stabiliza-
tion policies, in accordance with the authorities’ an-
nounced strategy, would enhance future growth.
Stronger oil revenues have improved the near-term
outlook for Nigeria but medium-term prospects re-
main uncertain. In Algeria, which has shown impres-
sive stabilization gains, public enterprise restructuring
and privatization are needed to enhance the medium-
term outlook, although the security situation greatly
complicates the tasks of economic policy. Morocco
and Tunisia also need to step up the pace of structural
reform to further enhance their growth prospects. In
both Algeria and Morocco, however, high unemploy-
ment, while making economic growth all the more im-
portant, also constitutes a difficult social setting for
stronger reform efforts. Overall, Africa’s recovery re-
mains fragile and, in spite of recent successes, it is still
a great challenge for Africa and the international com-
munity to reverse the decline in the region’s living
standards over the past quarter century.
Sharply contrasting economic trends have emerged
during the past decade or so in the developing world.
Some countries, such as Chile and Malaysia, have
13
benefited considerably from strong macroeconomic
policies and outward-oriented, market-based reforms,
which are enabling them to integrate rapidly into the
global economic and financial system. With their al-
ready relatively high per capita income levels, these
countries are firmly on the road to joining the ranks of
the advanced economies along with the newly indus-
trialized economies. Other emerging market econo-
mies like China, Thailand, and Indonesia are similarly
showing impressive achievements even though con-
vergence will, of course, take longer given their lower
levels of income. The economic success of all of these
economies reflects the mutually reinforcing effects of
sustained progress in many areas of economic policy.
Their major policy challenge for the future is to con-
tinue to deregulate product, labor, and financial mar-
kets, while guarding against domestic and external
imbalances and financial sector fragility. If these con-
ditions are met, the benefits of economic reforms
should continue to be reinforced by the forces of
globalization.
A large part of the developing world, however, has
not yet reaped the benefits of globalization: many
countries have seen their living standards grow only
modestly and have continued to lose ground in relation
to the advanced economies. This is the case, for ex-
ample, in the Indian subcontinent, and much of the
Middle East and Latin America. Although there is no
simple recipe for improving economic performance,
there are strong indications that these countries have
made inadequate progress in improving the policy en-
vironment. Policy shortcomings are in many cases not
across the board but in some critical areas such as the
failure to sustain macroeconomic stability, delays in
liberalizing foreign trade, or inadequate progress in
deregulating domestic product markets, establishing
market-based institutions, and improving governance.
Many of these countries are increasingly realizing the
need for more comprehensive strategies and are be-
ginning to see the fruits of their efforts as illustrated,
for example, by the recent experiences of Argentina,
Jordan, the Philippines, and Uganda.
Some of the poorest countries, especially in Africa,
have fallen behind not only in relative but also in ab-
solute terms. These countries are facing a general need
to open their economies, reform government, establish
financial markets, and maintain internal and external
financial stability. To help them cope with the enor-
mous challenges they are facing, the international
community needs to provide well-targeted assistance
and to lessen external debt burdens, which have risen
to unsustainable levels in some cases. In addition to
special low-cost lending facilities to support the ad-
justment efforts of the poorer countries, the IMF and
the World Bank have launched a joint initiative, which
will provide further assistance to help reduce the debt
burden of heavily indebted poor countries that have
followed sound policies but for whom traditional debt-
 I GLOBAL ECONOMIC PROSPECTS AND POLICIES
relief mechanisms have failed to secure a sustainable
external position.
Transition Countries
The transition countries also display sharp contrasts
in performance. Those that are the most advanced in
the transformation process are now reaping the re-
wards of comprehensive reform and stabilization poli-
cies pursued with determination over several years.
These include Poland, the Baltic countries, Croatia,
the Czech Republic, Hungary, the Slovak Republic,
and Slovenia. Most of these are experiencing rela-
tively robust economic growth, moderate inflation,
and promising progress in their reintegration into the
world economic and financial system. In fact, several
are now experiencing some of the policy challenges
that come with successful reforms, including the need
to manage large capital inflows, contain the associated
external current account deficits, and deal with other
signs of overheating. These problems can best be ad-
dressed by pursuing strong stabilization policies and
continued structural reforms, including privatization
and financial market reforms.
Those that are less advanced in the transition are
struggling with a number of policy challenges. Several
have made good progress, and in Armenia, Azerbaijan,
Georgia, Kazakstan, and the Kyrgyz Republic, infla-
tion fell considerably and growth picked up in 1996
with prospects of continued expansion in 1997. In
Russia and Ukraine, inflation has also fallen, but a
clear turnaround in output has yet to emerge. All of
these countries need to consolidate progress with sta-
bilization, including by reforming tax systems, im-
proving revenue performance, redefining public ex-
penditure priorities, and dealing with the pervasive
problems of arrears and nonpayment. Greater progress
is also generally needed in structural reform, espe-
cially privatization, the establishment of market-based
institutions, and the strengthening of property rights.
Many of these countries also need to deal with fragile
14
banking systems. Measures to address Bulgaria’s seri-
ous financial crisis are now being implemented in the
context of a stabilization program supported by the
IMF.
The reintegration of the transition countries into the
global economy through trade and financial flows is
critical for the success of the transformation process.
At the same time, reintegration is bound to take time.
Most progress has been made in the liberalization of
trade and payments arrangements, which has been re-
flected in a marked reorientation of trade flows.
However, there has been considerable variation across
countries in the pace and extent of trade liberalization,
and in the ability to take advantage of new market op-
portunities. Progress in financial market integration is
necessarily less far advanced and will require the es-
tablishment of a stable, investor-friendly environment.
Even so, foreign direct investment already plays an
important role in the most advanced transition coun-
tries and private portfolio inflows have also increased
sharply in a number of cases.
Financial market integration provides both chal-
lenges and benefits for the transition countries.
Increased financial linkages with the world economy
tend to amplify the effects of sound policies by pro-
moting capital inflows and lower interest rates. These
benefits can be misused: a country may borrow more
merely to increase consumption. But if there is such a
lack of self-discipline in policies, open financial mar-
kets will eventually impose their own discipline, pos-
sibly at considerable cost. This threat should help pro-
mote necessary policy changes. Capital inflows also
allow the countries in transition to sustain the high lev-
els of investment needed to revitalize industries and
replace obsolete capital equipment. At the same time,
it needs to be recognized that large-scale capital in-
flows can complicate macroeconomic management
and that there is a need to guard against excessive ex-
ternal current account deficits and changes in investor
sentiment. Because of such concerns, liberalization of
capital account transactions is likely to be gradual and
will depend on progress in other areas.